Thomas Pascoe worked in both the Lloyd's of London insurance market and in corporate finance before joining the Telegraph. He writes about the financial markets. His email is thomas.pascoe@telegraph.co.uk and his Twitter address is @PascoeTelegraph

Britain is following Argentina on the road to ruin

A faltering economy, a coalition government torn between spending cuts and tax rises, a sinking currency, money printing and 'unconventional' monetary policy. Britain in 2012? No, Argentina in 2002.

The problems faced by Argentina a decade ago and by Britain are eerily similar. In each case the government believed that through its own sophistication and trickery it could defeat a debt crisis of its own devising. In Argentina, every government action served only to make the situation worse. We are following the same path.

In 1998, Argentina entered what was to become a savage depression. Like Britain, it had previously been a poster boy for free-market capitalism. It was also considered a regional safe haven thanks to its open markets and business-friendly government. Like Britain, Argentina's financial sector was a magnet for foreign investment: one quarter of JP Morgan's emerging market bond portfolio was invested in Argentina before the crash.

As in Britain, the crisis of 1998-2002 was predominantly one of debt. It began once credit markets froze – in Argentina's case this followed currency crises in Russia and Brazil which spooked the market.

Argentina's crisis ought to have been a shallow one. Instead, a series of spectacular misjudgments ensured that its economy shrank 28pc, the peso fell to a third of its pre-crash value against the dollar, inflation hit 41pc, unemployment reached one quarter of the workforce, real wages fell 24pc, and over half of the population fell below the poverty line.

At each stage, Argentina's recovery was sabotaged by the actions of its own politicians, as can be seen in this report published by Jim Saxton, Vice Chairman of the Joint Economic Committee of Congress.

As is the case in Britain (with an 8pc budget deficit), Argentina (which had a 2.5pc budget deficit) recognised that it would need to reduce the gap between spending and tax recipts. As in Britain, the ruling coalition could not make significant tax cuts because it owed its majority to a minor party of the Left.

Instead, it raised taxes. Signs of a recovery were apparent in December 1999 when the government implemented the first of three packages of tax rises. It increased the top rate of income tax, the wealth tax, and consumption taxes on drinks, tobacco and cars. Two years later it introduced a financial transactions tax and a hiked the petrol tax.

These are the sort of measures that might be reccommended by a Lib Dem or Labour politician today. The effect of the Argentine tax increases was to amplify the recession. At the same time, the deficit expanded because state spending could not be tackled and tax take falls in a shrinking economy.

In short, the Argentinian government substituted actions which might close the deficit for empty words, just as George Osborne does now.

In both countries, asserting credibility took priority over sensible policy making. In Argentina's case, a convertability crisis caused the government to propose an end to the country's dollar peg. Having been promised that nothing of the sort would happen, the markets took fright and borrowing costs shot up. I see the same fate overtaking Britain come December, and the formal abandonment of Osborne's debt and deficit targets.

The remarkable thing about the Argentinian crisis was that it was driven almost entirely by the public sector. Between 1994 and 2000, it increased net debt from $43bn to $58bn, while the net assets of the private sector rose from $22bn to $29bn.

It was government meddling in the Argentine banking system which contaminated the private sector and made credit impossible. Monetary policy motivated by a desire to please the bond markets made things worse. In Argentina, interest rates were artificially high to try in order to support the currency and hence the dollar and dollar/euro pegs. In Britain, QE represents an even more direct interference in the market mechanism. Both excesses cause damage in the long run by stopping the markets from checking the advance of government debt in a gradual way.

Our problems, too, have become problems of the public sector. Every solution proposed thus far at both Lib Dem and Labour conferences has presented the state as wiser than the market, yet the market is now recovered from its 2007 sickbed (albeit with several injections of state finance), and it is state finances that are ailing.

Britain is not Argentina, and lacks some of its problems. A nation such as Spain, which must also maintain an arbitrary and over-valued currency peg, is an even better match. However, at a time when wonkish technocrats call for more tax, more spending, more government and more interference, we would do well to remember the lessons of the past.